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Why is my Mutual fund Under performing even though the Financial Market seem to be doing well?

Since the last year and a half, many investors are puzzled when they look at their mutual fund portfolios.  If you are one of those who has a well diversified portfolio (which is the way to go), you would find that some of your funds are doing extremely well whereas there are some others that despite the financial markets going up, are giving dismal returns leading to the obvious and an uninformed question that; " why am I even investing in these slow performers?" and "why not invest everything into the leaders rather than the laggards?" Curiously, many of these under performers had been performing above par and the lag is seen only if the  investment has been recent(about 1-2 years old). Surprisingly same funds, if purchased about 5-7 years ago are showing double digit returns...confusing right? 

The confusion becomes even more pertinent when the equity market is breaking barriers and a few mutual funds in your portfolio are stuck at the bottom. So why is this happening? Why is a particular mutual fund in your portfolio lagging?

To answer this question, one has to understand how investors typically choose a mutual fund.  99% of the investors choose on the basis of past performance of 1 to 3 years with little regard to any investment strategy. This is a perfect recipe for an investment disaster. 

To elaborate this even further, let us understand how do mutual funds invest your money.  Well, some would say ;"Oh thats simple!" "The fund house collects funds from various investors and invests across a diversified basket of stocks that are supposed to generate returns which are then passed on to the investor." After all the main QR of a mutual fund should be to generate wealth for the investor! But is it so simple?  Shouldn't we be talking about investment horizons or investment styles? To many investors the mutual funds or share market is a means to create quick wealth.  This could not be any further from the truth. Equity markets are most conducive for long term wealth creation and reward the patient. The obvious reason for this is that over long term(over 5-10 years), the volatility of the financial market plateaus out and the risk gets mitigated.

Having spoken about the investor behaviour(after all this is the single most important reason that makes the difference between wealth creators and wealth destroyers), the investment strategy cannot be not discussed.  There are typically two styles of investment that a mutual fund adopts for a particular fund and that is the Growth Strategy and the Value Strategy.

1. Growth Strategy: under this strategy, the fund manager believes that a particular company, based on the key fundamentals is going to grow fast in the future, even though it may be priced expensive or over valued. Growth stocks are largely consumption based and include private companies.  
2. Value Strategy:  Under this category, the fund manager would typically bet on stocks that are attractively priced or are at lower valuations. In markets like the present, when inflation and Geo political tensions are high and the Government focusses on capital expenditure, Commodity, Government or PSU type of stocks would do well. Such stocks do well when the markets are expensive because many fund managers would want to buy cheap based on their research.

An obvious question at this point would be, "So Which is a better strategy...the Value or the Growth?" All simple questions need not necessarily have simple answers and there is no simple way to answer this too!  What is however, certain is that there is no right or wrong in both the styles. If the investment horizon is long enough(about 10 years), both would deliver returns. That is why same funds held over long term deliver better returns than if held for short term.

Post COVID in 2020, The World economies have been flush with high liquidity on the back of high currency infusion.  The fallout of this has been a higher than usual inflation. In such a scenario, the value investment strategy benefitted and that is why after a run of more than 7 years by the growth stocks, the value has been the flavour of the season since the last two years or so. 

Coming back to the investor mindset of picking out the best performing funds based on the last 2-3 years, it is no surprise then that funds like Axis, Canara, most FlexiCaps etc that bank on the growth strategy, having performed well pre COVID, are now at the receiving end of marginal CAGR on their best and flag ship funds. Remember, if you choose funds based on the last few years performance, you would obviously end up picking out funds that followed a style that was working at that point of time and  as the market cycle changed, which it does every 2-3 years, these funds in your portfolio that do not follow the current style start to falter. 

The proof of the pudding lies in its taste and the best way to understand this is with an example.  The Banking sector is at the top today and the IT at rock bottom.  if you had money to invest, what would be your preferred choice; Banking or IT?  Your choice would help you understand the question at hand very well.

To sum it up, few things that an investor needs to remember is that if the investment horizon is long enough, both growth and value would do well. so it would be advisable to add both types of funds to your portfolio.  Each would balance out the other in short term and in long term your portfolio would be a winner.  That should answer the question of whether one should exit the growth strategy funds if they are not performing and vice versa in an inverse cycle or rather have a well defined portfolio with both flavours.

A few pointers that can help you create wealth :

1. Never judge a fund only on returns over a short term period.
2. Equity Investments are for long term of at least 5-10 years.
3. Have a well diversified portfolio.
4. Frequent churning only results in short term gains and exit loads. 
5. Have an investment strategy in place.

Be an informed investor and invest right to create wealth!

Anupama Bhargava CFP